European Banks holding European sovereign debt may have to take haircuts and be part of bail in plans should that same debt default, according to a plan being pursued by German government advisers. In another attempt to shelter German tax payers from the largess and excess of fellow European neighbouring countries’ national banks, the move could trigger a run on billions of euro of sovereign debt of said banks. In an article penned by the Telegraph’s Ambrose-Evans Pritchard, one of the council’s dissenting members describes the plan as the “fastest way to break up the Eurozone”.

The plan, by The German Council Of Economic Experts, calls for banks to be bailed in should losses occur from a sovereign default before the European Stability Mechanism steps in to stabilise the situation.

Italian and Spanish banks hold vast amounts of their national government debt; in Italy’s case they are supporting the Italian treasury. Should that debt default, which is a very real possibility, then Italian banks would have to take significant losses first, only then would the ESM be allowed to step in.

Professor Bofinger, who sits on the council, has dissented. He believes that such a move could force Italy and Spain to actively depart from the euro in order to prevent their countries from facing bankruptcy. The mere prospect of such a move could ignite a bond run and cause the collapse of European sovereign debt, forcing up yields and crashing bond prices. This would mean that European nations would face far higher refinancing rates.

So will it happen?

So far the plan has attracted a number of high profile supporters, including the influential German Finance Minister Wolfgang Schauble and the German Bundesbank. When questioned about the plan, ECB president Mario Draghi stated, tellingly, on Monday that “…it is an issue that we do have to deal with. But we have to take a very considered and phased-in approach”. Portuguese 10-year bonds are already trading at yields not seen since 2014.

What does it mean?

It means that national banks facing losses from government debt defaults cannot now rely on official support until they have expended their own reserves, which may include the expropriation of customer deposits. Should a heavily indebted European country default on its bonds, any bank holding said bonds will have to cover the losses by tapping its existing reserves. The losses may then suck in client deposits as bank depositors get forced to cover the capital shortfall on the bank’s balance sheet. The possibility of contagion then rises as counterparties to the bank and the defaulting government dump any related assets or parties they suspect as having exposure. It is a house of cards that could destabilise the entire monetary system.

European integration is a mess and it will likely end very, very badly. The noble euro experiment has exposed deep chasms of distrust which the architects of the EU felt would be overcome only by throwing each member’s lot in together. Alas, we now see that German benefactors are circling the wagons in anticipation of a collapse by digging firebreaks wherever they can. They are following a nationalist mandate to protect their citizens from the excesses of their neighbours, utterly misdiagnosing the causes of the issue in the process. If you were in Whitehall, London and tasked with drafting a policy paper for Britain and its integration with Europe, what would you think? You would likely seek to make serious preparations for a disorderly wind down of the European monetary experiment.

Myopic

German conservative financial elite refuse to accept any shared responsibility for the euro, that much is clear. They believe in having their cake, (a vastly depreciated export currency that ensures competitive and high value German exports), and eating it too (refusing to support by a system of transfers the benefit accruing to the German tax payer with their fellow debtor nations). The machinations of European debt problems should be shared. The peripheral European countries should take a disproportionate amount of any financial adjustment pain resulting from their greed and poor management, but the process by which this is achieved needs to be managed far more sensitively and in concert with those European neighbours. It seems that this plan may create the very storm it seeks to manage.